Gold Futures Looking Bullish

Gold has rebounded sharply higher in the past month, taking the early lead
as 2017's best-performing asset class. Normally such a big gold surge would
require heavy gold-futures buying by speculators. But they've been missing
in action, barely moving any capital into gold yet. Their collective bets on
this metal remain very bearish. Since they are such a strong contrarian indicator,
that's a very-bullish omen for gold.

The sole mission of speculation and investment, and thus all the endless research
that feeds into it, is to multiply wealth. Traders can't effectively buy low
and sell high unless they understand what drives the prices of their
trades. For years now, gold has had two overwhelmingly-dominant drivers. Their
capital flows fully explain the vast majority of all gold's price action, and
thus are exceedingly important to study.

The first is the world-leading GLD SPDR Gold Shares gold ETF. This acts as
a conduit for the vast pools of American stock-market capital to slosh into
and out of physical gold bullion. Differential supply and demand for GLD shares
relative to the underlying gold supply and demand is directly shunted into
gold itself. GLD's physical-gold-bar purchases and sales as its holdings grow
and shrink greatly impact gold prices.

Nothing has been more important for gold over the past year than the American
stock-market capital that flowed into then out of it via GLD. Speculators and
investors can't understand where gold has been or where it's likely heading
without studying and closely watching GLD's gold-bullion holdings. Last week
I wrote a comprehensive
essay digging into this crucial GLD-and-gold relationship in depth, check
it out.

But American speculators' gold-futures trading often overpowers American investors'
GLD-share trading in bulling the gold price around over the short term. Futures
speculators enjoy an outsized impact on gold prices wildly disproportionate
to the capital they wield for a couple key reasons. First, the American gold-futures
price is gold's de-facto world reference price. It is the most-widely-followed
and quoted gold read.

So when these traders buy or sell aggressively and thus rapidly force gold
materially higher or lower, it has a big psychological impact on everyone else
in the gold world. Gold futures are the speculation tail wagging the far-larger
investment dog in gold. Investors controlling vastly more capital than gold-futures
speculators get bullish or bearish, and change their trading behavior accordingly,
based on gold-futures action.

Second, gold-futures traders enjoy a radically-inordinate influence on gold
thanks to the extreme leverage inherent in gold futures. While investors
buy gold outright or with at most 2x leverage through GLD shares, gold-futures
speculators often trade gold with incredible 20x to 25x leverage! That means
every dollar of capital bet on gold futures can have 20x to 25x the price impact
of another dollar invested normally.

So futures speculators' collective buying and selling can really distort gold
prices over the short term, even though gold investment demand will
always ultimately prevail as gold's primary driver. There's a critical interplay
between GLD capital flows and gold-futures action. Parallel buying or selling
on both of these fronts always drives gold higher or lower. Opposing buying
and selling tends to offset and cancel out.

Unlike GLD-holdings data which is available daily, speculators' collective
gold-futures trading activity is only published at a fuzzier weekly resolution.
Late every Friday afternoon the CFTC releases its famous Commitments of Traders
reports. These reveal what both hedgers and speculators have been doing in
gold futures current to the preceding Tuesday. Watching them is essential to
gaming gold price action.

This first chart looks at the aggregate gold-futures long and short positions
held by both large and small speculators, in contracts. Each gold-futures contract
controls 100 troy ounces of this metal. Total longs or upside bets on gold
are rendered in green, while total shorts or downside bets are shown in red.
The yellow line shows the deviation of both these bets from normal years' average
levels between 2009 to 2012.

Speculators' gold-futures data may look complex, but it's not difficult to
understand. Gold's price over the past couple years or so is superimposed in
blue. Gold is strongly positively correlated to speculators' total gold-futures
longs. Every significant gold rally in recent years was partially driven by
big gold-futures buying as evidenced by spec longs surging. Until this past
month's rally, which we will get to.

Speculators' collective upside bets on gold are also a powerful contrarian
indicator. Spec longs were high every time gold peaked in the last couple
years, including this past summer. As I warned back in mid-July just after
gold hit $1365, it faced a record
gold-futures selling overhang due to specs' excessive longs. These hyper-leveraged
traders were far too bullish, all-in on gold, implying they would soon have
to sell.

The higher spec longs, the more bullish on gold these traders are. But that
means they have already deployed most of their available capital, with limited
firepower to push gold still higher once they're all crowded in. So gold rallies
often peter out and then reverse once spec longs get excessive. The worst time
to get excited about gold is when futures speculators are, since they are the
most bullish when gold is topping.

Conversely low spec longs show when these traders are bearish. They don't
expect much upside from gold so they've liquidated large fractions of their
leveraged long bets. That signals most of the gold-futures selling has already
happened, so gold is actually bottoming. Spec longs were really low
back in December 2015 when gold was carving a major 6.1-year secular low.
That birthed last year's strong new bull!

So the smart way to game gold's probable near-term price action is to do
the opposite of what the futures speculators as a herd are doing. If
they are betting big on higher gold prices as shown by excessive longs, expect
an imminent correction. If they are convinced gold is heading lower as seen
in low longs, expect a major rally to soon erupt. Fading the futures-speculator
mob is the surest way to win in gold trading!

Speculators' collective gold-futures short positions work similarly, but in
the other direction of course. In futures, traders can sell even if they don't
own any contracts to sell. They effectively borrow them from someone else,
and then sell them. These debts must soon be repaid, so speculators hope they
can buy back the futures contracts at lower prices to return them.
They then pocket any difference as profits.

In terms of gold-price impact, there is zero difference between a speculator
selling long contracts they already own or short selling ones they don't.
A sale is a sale, they are functionally identical. But since speculators collectively
hold fewer gold-futures shorts than longs, shorting has a proportionally-smaller
effect on prevailing gold prices. But once again speculators bet wrong as a
herd when gold is ready to reverse.

Gold's major secular lows in 2015 were accompanied by record-high spec short
positions! Right when gold was bottoming ahead of major rallies, these guys
were holding the largest downside bets. Then as gold subsequently topped, spec
shorts had been bought and covered back down to low levels. So gold is most
bullish over the near term when speculators are the most bearish as evidenced
by excessive shorts.

Futures speculators are always wrong at extremes, when gold has either
rallied or corrected too far for too long. High spec longs and low spec shorts
are a key warning sign of a major selloff looming, just as I warned
last summer. But low spec longs and high spec shorts signal the opposite,
that gold is on the verge of embarking on a major new rally. This latter very-bullish
situation is exactly what gold is seeing today!

This chart zooms in to the past year or so, but let's start on Election Day.
That night as Trump pulled into a surprise lead in the biggest battleground
state of Florida, gold futures rocketed 4.8% higher to $1337! A Trump win was
universally assumed to be bad for stock markets and thus good for gold, which
is the anti-stock trade since it tends to move counter to stock markets.
As stocks rebounded, gold was sold hard.

This heavy post-election gold selling was universal, coming from both investors jettisoning
GLD shares and speculators dumping gold futures. With capital rushing
out of gold's two primary drivers, it was just hammered. In the 5 weeks between
Election Day and the day after the Fed's second rate hike in 10.5 years in
mid-December, gold plunged 11.5%! That was part of a larger 17.3% major correction
since early July's peak.

Gold's two biggest plunges in its miserable Q4'16, one of its worst quarters
ever, were fueled by heavy gold-futures selling by speculators. Since
such extreme leverage exists in this market, traders have to set tight stop
losses. If they are running 20x leverage, a mere 5% adverse move in gold against
their bets would wipe out 100% of their capital risked! So even minor 1%ish
gold moves are major for futures traders.

In early October as gold drifted towards $1300, it triggered a big mass of
futures stop losses set near that key psychological support. The resulting mass
stopping quickly cascaded, as the more gold futures fell the more stops
were tripped unleashing even more selling. Another mass stopping happened just
two days after the election when another key gold support zone at its 200-day
moving average failed to hold.

These extreme early-October and mid-November episodes of gold-futures selling
perfectly illustrate how disproportionate its impact can be. Speculators dumped
43.4k and 45.6k contracts respectively in those two key CoT weeks, unleashing
the equivalents of 134.8 and 141.9 metric tons of gold. That is far too much
selling for the gold market to absorb in such short spans of time, which cratered
the gold price.

For perspective, consider the latest global gold fundamental data available
from the World Gold Council current to Q3'16. That 9-month year-to-date span
saw massive
gold-investment demand, huge by recent years' standards. Yet it still only
averaged 35.6t per week. So whenever gold-futures speculators get spooked or
forced into dumping 100t+ in single-week spans, gold is certainly going to
get kicked in the teeth.

The resulting sharp drops really crush gold psychology, leaving investors
and speculators alike much more bearish and pessimistic. They start to extrapolate
that trend, expecting gold to keep falling farther. So they buy less or sell
more, and gold's futures-driven selloff soon becomes self-feeding.
It is amazing how much gold futures impact overall gold sentiment, these speculators'
influence is wildly disproportional.

That extreme post-election selling initiated by speculators' gold-futures
stops being run finally ran its course by the day after the Fed hiked rates
again last month. Futures speculators have long feared Fed rate hikes' impact
on gold, which is supremely irrational. During the exact spans of all 11 previous
Fed-rate-hike cycles since 1971, gold rallied an average of 26.9% higher!
They have proven
very bullish for gold.

By the time gold finally bottomed last month, its correction had ballooned
to 17.3%. That is huge, but still shy of 20%+ new bear territory. In addition
to heavy differential GLD-share selling, the other primary driver was heavy
gold-futures selling by the speculators. Over that entire correction span since
early July, they had liquidated an astounding 174.0k long contracts while adding
32.2k short ones, serious selling.

That equates to 641.3 tonnes of gold, or nearly half of the 1389.2t
of global gold investment demand in the first 9 months of 2016! Speculators
had unwound fully 69.8% of all the long positions they had added to help drive
gold's new 29.9% bull market between mid-December 2015 and early July. All
this extreme selling along with GLD's blasted gold so low that it erased a
staggering 75.4% of its bull's progress.

With speculators fleeing gold futures at a magnitude that defies belief, they
had to be exhausting their selling as I wrote
in mid-December. These traders only have so many contracts they can sell,
so the more they've sold the less selling is still to come. And soon after
gold's 10.6-month low in mid-December, these gold-futures spec long positions
had collapsed back down to 255.7k contracts. That was a 10.4-month low.

American speculators hadn't held fewer gold-futures longs since way back in
mid-February before gold had even entered new-bull-market territory yet at
a 20%+ gain. So with the great majority of the entire young bull market's gold-futures
long buying already unwound, spec longs are very low today. That is a super-bullish
omen just like it was at past major gold lows. These traders have vast firepower
to buy back in!

A week after that recent longs low, spec shorts surged to 138.6k contracts.
That was also the highest level seen since early February, and way above last
year's 95k-contract support line. While there was some modest covering in the
latest CoT report available before this essay was published, shorts are still
relatively high. That means speculators have to buy lots of gold futures
to cover and offset their shorts.

With speculators very bearish on gold today as evidenced by low longs and
high shorts, you couldn't ask for a more-bullish gold setup. Just as
in the past, gold tends to bottom right as these influential traders are
reaching selling exhaustion. That leaves nothing but buyers, so gold soon
starts rallying in major new uplegs. Indeed one has already begun, despite
futures speculators not doing any significant buying yet.

Major gold uplegs are usually born when speculators buy gold futures to cover
their short positions. As they are legally obligated to pay back those borrowed
contracts, and have to buy to protect their capital when gold rallies, short
covering is involuntary. Speculators do it regardless of how they feel about
the gold outlook. But that very short covering drives gold higher and starts
to erode bearish bottoming psychology.

So the much-larger contingent of gold-futures speculators on the long side
soon start buying as gold's short-covering-fueled rally convinces them it is
reversing higher. That starts to turn sentiment bullish again, with buying
begetting buying. Eventually that long-side buying drives gold high enough
for long enough to get investors, with their vastly-larger pools of capital,
interested in starting to buy gold again.

While we saw modest spec short covering of 6.4k contracts as of January 10th,
the last CoT data before this essay was published, there has been no material
long buying yet. Since that 255.7k-contract trough of spec longs a couple
CoT weeks ago, speculators have only added 2.4k contracts. That's practically
a rounding error. Seeing gold blast 7.7% higher in just a month with no real
gold-futures buying is remarkable!

And there hasn't
been any differential GLD-share buying either. Gold's initial rebound
out of its deep post-election lows apparently came from Asia. There
have been plenty of days in recent weeks where gold rallied significantly
overnight when American traders were sleeping. That global gold demand that
is pushing up prices without any help from gold's dominant couple drivers
is going to ignite big buying.

Sooner or later gold will have rallied enough to convince both American gold-ETF
investors and gold-futures speculators to return. And with specs' longs so
low and shorts so high, they are going to buy with a vengeance to mean revert
their excessively-bearish bets back up to more-normal levels. In addition to
higher gold prices, there are a couple more key catalysts that will soon spark
big gold-futures buying.

Gold-futures traders are highly sensitive to the US dollar, since gold is
ultimately the universal world currency. So as today's wildly-overcrowded long-US-dollar
trade inevitably
reverses, speculators are going to flood back into gold futures. They will
also aggressively buy when the overvalued US stock markets sell off and roll
over into their long-overdue
bear market, which will lower perceived Fed-rate-hike odds.

With speculators way too bearish today as their low longs and high shorts
prove, there's heavy gold-futures buying coming. It will catapult gold
sharply higher in the coming months, as always happens soon after these guys
as a herd get too pessimistic. Some combination of higher gold prices, a lower
US dollar and/or stock markets, and less-hawkish Fedspeak is going to soon
kindle serious gold-futures capital inflows.

This coming major new upleg in this young gold bull can certainly be played
with GLD or call options on it. But the gains in the gold miners' stocks will
dwarf the gains in gold, since their profits growth greatly
leverages gold's upside. As I discussed
in depth a couple weeks ago, we're already seeing that. Over that recent
single-month span where gold rallied 7.7%, the leading gold-stock index already
surged 25.3% higher!

At Zeal we aggressively bought and recommended great gold stocks and silver
stocks to our newsletter subscribers back in December when everyone remained
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The bottom line is the gold-futures setup today is exceptionally bullish.
Speculators grew excessively bearish in the wake of the election, dumping a
colossal amount of long contracts while adding plenty of shorts. This huge
liquidation left their longs low and shorts high, a strong contrarian indicator
that has always signaled major reversals higher in gold. These elite traders
as a herd are always wrong at extremes.

So big spec gold-futures buying is coming soon, which will help catapult gold
sharply higher again just like it did a year ago. It is already starting with
initial short covering, but will soon expand into far-larger long buying as
gold continues powering higher. After selling their longs to such low levels,
these influential traders will need to buy big for months on end to restore
normal positions. That's great news for gold!

If you have questions I would be more than happy to address
them through my private consulting business. Please visit www.zealllc.com/financial.htm for
more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that
I am not able to respond to comments personally. I WILL read all messages though,
and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst,
publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis
of markets, geopolitics, economics, finance, and investing delivered from an
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